Looser lending standards won’t inflate another housing bubble

Lenders lower standards to qualify more borrowers and increase business, a precursor to another bubble, but only if risk is again mispriced.

The recipe for a housing bubble takes many ingredients, and loose lending standards are one of them; however, it requires a gross mispricing of risk and enormous capital flows into unstable loans before prices get pushed up into bubble territory.

Let’s assume for a moment all qualification standards were eliminated and anyone who wanted to borrow money could get a loan, similar to what happened in 2004 through 2006. Would this cause a housing bubble? In my opinion, it would not. It would inflate prices, and it would cause a great deal of downward substitution of quality to get a property, but it wouldn’t necessarily create a housing bubble as long as loans were based on verifiable income and reasonable debt-to-income ratios on conventionally amortizing mortgages.

The loose lending standards of 2004-2006 allowed many people to buy homes, but it was the combination of liar loans, unlimited debt-to-income ratios, and negatively amortizing loans that allowed the army of borrowers to finance loan balances double what they should have been. Remember, housing demand is measured two ways: total number of buyers, and total amount those buyers can put toward housing. Increasing the number of borrowers can inflate prices through the substitution effect, but increasing the total amount buyers can put toward housing is what sends prices orbital.

Toxic loan programs like the option ARM were not invented during the housing bubble; they were long-standing niche products with a hefty price tag to properly price the risk of default. It was the gross mispricing of risk on Wall Street that created an insatiable demand for these products that drove the price down and put these weapons of financial destruction in the hands of unqualified borrowers. Prices wouldn’t have inflated nearly so much during the housing bubble if the risk hadn’t been mispriced through ruinous credit default swaps and collateralized debt obligations given AAA ratings by a corrupted rating system.

It’s right to be concerned about the return of some dangerous loan products. I expressed my belief that the new mortgage regulations will prevent future housing bubbles because the “Ability to Repay” rules will prevent reckless lending, but I could be wrong. These toxic loan products don’t conform to the new mortgage regulations, so right now they are very expensive and uncommon. If Wall Street misprices risk yet again, they could fund these non-conforming loans and inflate another housing bubble. We must pin our hopes on changes at the ratings agencies, new regulations, and institutional memory on Wall Street — we all have reason to worry.

Banks Ease Standards Enacted After the Housing Boom Turned to Bust in Sign of Rising Confidence

By Nick Timiraos and AnnaMaria Andriotis

Updated April 18, 2014 7:35 p.m. ET

The credit freeze is starting to thaw.

Mortgage lenders are beginning to ease the restrictive lending standards enacted after the housing boom turned to bust, a sign of their rising confidence in the housing market.

While standards remain tight by historical measures, lenders have started to accept lower credit scores and to reduce down-payment requirements. …

One such lender is TD Bank, Toronto-Dominion Bank’s U.S. unit, which on Friday began accepting down payments as low as 3% through an initiative called “Right Step,” geared toward first-time buyers and low- and moderate-income buyers. TD initially launched the program last year with a 5% down payment. It keeps the product on its books and doesn’t charge for insurance. Borrowers also don’t need to put down any of their own cash if a family, state or nonprofit group provides a down-payment gift.

This is an interesting development considering the FHA specifically banned the practice of down payment assistance because the default rates were 4 times higher; further, with no equity cushion, the default losses were much larger. My guess is that this loan carries a hefty price tag and has other onerous requirements.

The changes also are a recognition by lenders that the business of refinancing old mortgages, which had been a huge profit center for banks, is nearly tapped out. To generate future profits, banks will have to compete for borrowers who may not have perfect credit or large down payments. …

For now, economists and lenders say there are few signs of any return to the carelessness of the past decade’s destructive credit bubble. “Credit is loosening, but it is loosening from a tight starting point,” said Mr. Fratantoni of the MBA.

Bankers make money by making loans. With loan production at 20-year lows, some reduction of standards was inevitable if they want to remain in business.

The competition for new business is prompting some lenders to offer toxic loan products again — at a high price. From a recent email a reader forwarded me…

Adjustable-rate mortgages — the apocalyptical financial product of the recent economic collapse — are coming back in a big way. Of course, the banks insist that this time it’ll be different. At the moment, they’re targeting only high-net worth borrowers. According to a study that was developed for The Wall Street Journal, during the fourth quarter of 2013, roughly one-third of mortgages that ranged between $400,000 and $1 million, and nearly two-thirds of those over $1 million, were adjustable-rate mortgages.

But U.S. banks are under earnings pressure these days. Profit margins are shrinking, in part because demand for loans — mortgages in particular — has fallen off as interest rates have begun to rise and the economic recovery remains uncertain. Consequently, it’s reasonable to anticipate that lenders will once again rationalize their way to broadening the scope of their marketing efforts by relaxing credit underwriting standards . It also helps that ARMs end up shifting to borrowers the interest rate risk the lenders would otherwise have to take with fixed-rate loans.

The main reason lenders offer ARMs has nothing to do with helping borrowers. In fact, since the ability to repay rules require them to qualify the borrower at the maximum contractually allowed rate during the first five years, it doesn’t function as an affordability product. What it does accomplish is lower a borrowers payment somewhat while also transferring all the interest-rate risk onto the borrower. Generally, it’s a foolish move borrowers make due to myopia.

When interest rates are stable and low — as they’ve been these past few years — conventional loans rule. But when the economy starts to crank and rates begin to move, which is beginning to happen now, adjustable loans can become awfully tempting for both borrowers and lenders. The hook is a low monthly payment to start — often, meaningfully lower than for a fixed-rate loan. Later on, of course, you’re playing with fire.

The issue is how much heat can you stand? Start by asking yourself these questions:

How much room do I have in my budget for a bigger monthly payment in the event that interest rates move up?

What if credit becomes tighter or if interest rates move up so much that I can’t refinance my way out of the loan?

They’ll be forced to sell…

What if I can’t sell my house for a price that’s high enough to pay off the debt I have against it?

Then they’ll petition for a loan modification and likely get it.

It’s always better to plan for the worst rather than to be caught off guard by it.

Borrowers don’t appraise the risks. Everyone blithely assumes everything will go their way, and in our new era of mortgage moral hazard, they also correctly deduce they will be given a loan modification if things really go awry, particularly if enough of their neighbors make the same stupid decision and they all need help.

Although most prefer conventional loans to ARMs — because budgeted loan payments aren’t something many consumers like to see change — there are those who don’t mind playing with financial fire for other reasons (they expect to sell the house before the first adjustment period comes to pass, for instance). If you’re one of them, consider one last bit of advice: Don’t be greedy! Interest rates are still unusually low. Is the $100 or $200 payment advantage I described above really worth the downside risk? When rates are at rock bottom, it’s all downside risk.

I’ve been adamant in my opposition to using adjustable-rate mortgages, but with the moral hazard of inevitable loan modifications, I can no longer say it will likely cost people their homes. Of course, lenders will make those loan modifications totally in their favor, and they will drain all the borrower’s resources, the borrowers will at least keep living in the bank’s house, probably indefinitely.

Also, adjustable-rate mortgages can actually be better than fixed-rate mortgages if the contractual cap isn’t too high. The problem with ARMs has historically been the contractual cap is so high that borrowers can easily get in over their heads. If this contractual limit isn’t much higher than current rates on fixed-rate mortgages, the adjustable may be the way to go because the downside risk is minimal. Finding the ARM with a low contractual limit is another issue, and it may carry other costs that make it a poor choice. The details matter.

Looser lending standards are part of the complex puzzle that inflates dangerous housing bubbles, but it’s also a natural part of the credit cycle, and not necessarily destabilizing to the housing market or the broader economy. If we start to see a proliferation of non-conforming loans funded by Wall Street, then we need to be very vigilent because that sets up the market for a structural failure.

[…] Looser lending standards won't inflate another housing bubble What if I can't sell my house for a price that's high enough to pay off the debt I have against it? Then they'll petition for a loan modification and likely get it. It's always better to plan for the worst rather than to be caught off guard by it … Read more on OC Housing News (blog) […]

As a mortgage trader in the 90s and early 00s, I strongly disagree with your assessment of ARMS. In fact, ARMS are the smart product. When the economy is weak, you risk a job loss, and it is likely your pay is either falling or not increasing, and your home value is falling. Under these stressful situations, your ARM payment is falling since interest rates are falling.

And, when the economy is strong, your job is secure, your pay is rising, your home value is rising, and your ARM payment is rising.

What does this mean? Your ARM payment falls during weak economic periods, when you need it to, and this is offset with your ARM payment rising under strong economic conditions. This is a lower risk situation than a fixed rate mortgage, where under weak economic conditions, you are stuck with a high payment since your job situation and falling home values makes it impossible to refinance.

The only problem with ARMS occurred during the financial crisis … some ARMS tied to LIBOR had a rate surge because of intra bank lending problems. All my properties are on ARMS, and none of them were LIBOR, so I saw my payments collapse during the crisis. Fortunately, the FED flooded the system with money and put the LIBOR fire out quickly.

In my opinion, ARMS usually work out better. In my case, my payments have dropped substantially since I purchased my properties.

Most bond traders agree that ARMS are unfairly singled out for criticism in the media.

It’s been easy to be a fan of ARMs over the last 30 years because interest rates steadily declined. The fact that you and people like you believe these are good loan products is a manifestation of the moral hazard of central bank interventions with interest rates. The folly of ARMs will become apparent over the next 20 or 30 years as we chase the dragon of inflation with steadily rising interest rates.

Anybody getting a fixed rate since the early 80’s likely made a terrible mistake. I remember Jon Lansner used to brag that he bought in 1994 with a fixed rate mortgage as if it were a smart decision. Sure, all of the permabear readers lauded him for how wise he was to avoid “risky” products, yet financially it was a terrible mistake. Thousands of dollars in the trash can.

When I bought in 2010, I got a fixed rate because my expectation was to hold the property for at least 20 years, and I believe interest rates will be higher for a significant amount of that time. However, it’s entirely possible that I too made a terrible mistake. Only time will tell if my gamble pays off.

People need to realize that fixed rate mortgages are a potentially costly gamble.

I would consider an ARM with that spread. On an $800k loan, that’s $3,936 vs. $3,213, or $43k+ over 5 years. Of course, when we buy again, we’ll be debt-free and the DTI will not exceed 20%. If we used a 5/1 ARM, the plan would be to save a serious war chest in the first five years to combat potential rising rates.

Nonetheless, in an economy (of-late) being driven-by financial ‘churn’, it’s entirely possible that ALL types mortgages are ”potentially a costly gamble”.

ie.,

Should the last nail ever be pounded into the ‘petro$ standard’ coffin, it’s entirely possible that a ~40% devaluation event could instantly commence. It’s also entirely possible that debtors would NOT be permitted to walk away (as before), and ALL debt contracts could be rewritten to be paid back, NOT in the new, depreciated dollar/currency, but @ fair(stated?) values.

“People need to realize that fixed rate mortgages are a potentially costly gamble.”

If interest rates go down, you will have opportunity to refinance, and if rates go up, you are protected. I don’t see the gamble involved.

Borrowers pay a premium to pass interest rate risk back on the lender. If that risk is high, which it is now, lenders increase the spread between fixed-rate and adjustable rate mortgages to price the premium appropriately. As Perspective points out below, right now the risk premium is quite high because everyone anticipates rates going up.

Why not do a feature article in regards to ARM vs. Fixed on the site? Take the 12MAT, 6 month libor, and COFI. Put it to the test over the last 40+ years? Use a spread of 2.5 on the 12MAT, 2.25 on the 6 month libor, and 2.75 on the COFI. These are average margins(I once had a loan that was libor + 1). There is no sense in arguing what the better deal is without the numbers. My money is that the average ARM rate will be much lower. An ARM is a useful tool to those with disposable income. One should have to show 12 months reserves to get one.

Any test run in a declining interest rate environment will make the ARM look better. However, it also assumes the fixed-rate borrower didn’t refinance as rates declined as well.

The fact is that a fixed-rate mortgage has the same downward adjustability feature as an ARM, but it never goes up.

The only way to accurately determine which is better is to calculate the additional cost of fixed-rate financing by looking at the historic spread. While interest rates are falling ARM borrowers gain the advantage of the spread as fixed-rate borrowers refinance as well. Then, in those bursts when interest rates go up, those with fixed-rate financing make up the difference. Even over the last 30 years of steadily declining rates, there were periods when being locked into fixed-rate financing more than made up the spread.

Of course you were. You would not mention the facts as they pertain to the conversation if they do not fit your contention. Or didn’t you notice that the conversation was about fixed rate vs ARM; but not just for the last couple years since the collapse. No one said anything about since the end of time, or the last couple years, but it reasonable to assume that people were talking about a reasonable amount of time, not just that which fits your argument.

“If over 90% of mortgages are fixed rate, it means that’s what loan officers are pushing borrowers into. Why would they do that?”

Just wondering, why would the pros and cons of fixed rate mortgages and ARMs be any different in recent years than since those originated before? Why did you ONLY refer to recent mortgages to make your point? Call me a cynic, but if your intention was to ONLY refer to the percentages of recent years when people are speaking of the differences in fixed rate vs ARM with absolutely no reference to a particular small window of time, then you are saying that you were being intentionally misleading.

If you had said, “Oh, I did not realize that the 10% figure was only relevant to a very small recent time period”, then one could say you realized your mistake. But, it you say that you intended to use a non-representaional percentage, then you intended to mislead.

“In the view of some analysts, households are largely myopic. They choose between adjustable-rate and fixed-rate mortgages simply by comparing the initial interest rates they would have to pay on the two contracts. This view would imply that the initial spread between the fixed mortgage interest rate and the ARM interest rate is the primary driver of the ARM share.”

“A final demand-side hypothesis is that consumer sentiment has simply shifted away from ARMs, perhaps because of negative publicity about interest rate resets on subprime ARMs. While we do not test this hypothesis directly, a finding that the ARM share in recent years has been low relative to normal historical patterns would be consistent with such an explanation.”

“Finally, the Fed’s Large-Scale Asset Purchase program— designed to support the mortgage and housing markets through purchases of agency mortgage-backed securities and other assets—may have shifted demand toward fixed-rate mortgages.10 Because all of the mortgage-backed securities purchased were backed by fixed-rate loans, the program may have disproportion- ately reduced primary fixed rates relative to ARM rates. We investigate this possibility by examining changes in the ARM share around the time of the announcement of the LSAP program.”

So, it turns out that the ONLY RECENT low percentage of ARMs to total mortgages has nothing to do with any supposed advantage to the borrower and instead is driven by the fixed rate demand of quasi-government mortgage backed security inclusion. And the former ARM popularity was driven by the “buy the payment” mentality.

The Fed is juicing the secondary market by buying fixed rate mortgages. Lenders are able to sell fixed rate mortgages into the secondary market for a higher premium than ARM’s because they are selling into a manipulated market, not a free market. Therefore, lenders encourage their loan officers to steer borrowers towards fixed rate products because that is the most profitable move for the lender.

Luckily, the MSM and blogs like this continue to perpetuate the myth that fixed rate mortgages are “safer”, which makes selling the borrowers on this concept a lot easier.

Prior to the crash, loan officers were incentivized to originate pick-a-payment product with much higher commissions. The reason is because these loans sold for a higher premium in the secondary market due to the high interest rates and perceived “safety”.

Also, mortgage investors HATE early payoffs and foreclosures. They are both loss events. It’s rare for a foreclosed property to have enough equity (if any at all) to cover the costs of lawyers, courts, property preservation, etc.

You talk about refinances as if they are given for free, but in reality they are quite expensive. Not only do you pay at least a couple grand in fees, but more often than not you are resetting your amortization and getting stuck with more years of interest payments and slower amortization.

I’ve outlined before the costs to fixed rate mortgages compared to ARM’s:

I’m going off memory, but the example of a $500k house would save the average person about $50,000 (interst cost, amortization cost, + opportunity cost) over the first 10 years by choosing an ARM over a 30 year fixed.

Anybody owning a house for less than 10 years, should NEVER, EVER get a fixed rate loan. The need for the so-called rate protection premium is completely unnecessary because you are ALREADY PROTECTED from rate increases by choosing the appropriate fixed rate period prior to the first interest rate adjustment.

Since the average house turns over every 7 years, the banks are making a ton on people unnecessarily paying the interest rate premium that you tout. Your interest rate premium costs as much or more than healthcare insurance… and it insures absolutely nothing!!!

If you plan to own longer than 10 years, then it starts to make sense to consider a fixed rate particularly if you think rates will increase over the long term. However, you still might not recoup the savings from the first 10 years of using an ARM unless interest rate increases are enough to make it worthwhile.

I am sure you know the numbers. And I am even more sure that you know how to figure out what is the best, numbers wise. I don’t know if in your position if you meet with potential loan borrowers, but if you do, you may want to consider that for the majority of borrowers, a fixed rate loan is better in the long run for them, and when they tell you that, they aren’t just talking about numbers.

For most people, owning a $500,000 home outright is better than borrowing and investing the borrowed funds for a 1% or 2% advantage.

Owning a home is very rarely a strictly financial investment. This from someone who has speculated on So Cal residential real estate most of his adult life.

“People need to realize that fixed rate mortgages are a potentially costly gamble.”

From the perspective of what might cost more or less down the road, (in the furture), it seems that both carry an equal risk. I doubt if Joe 6-pack finds it advantageous to bet one way or the other on the future of interest rates.

A fixed rate results in a known payment amount. An ARM results in a constantly changing payment amount. For most, it would seem the former would be desirable.

The chance of paying less in the future does not outweigh the chance of the payment increasing to the point of unaffordability and the loss of one’s equity. One is a nice surprise. The other is devastating.

“However, it’s entirely possible that I too made a terrible mistake. Only time will tell if my gamble pays off.”

Other than the fact that all you make are mistakes, … just kidding. From my point of view, you did the opposite of taking a gamble. You went the more conservative and known route. You will most likely reach your goal. If you had chosen the unknown short-cut, you may have reached your goal faster, or you may have driven off a cliff.

Tell me the future, and I will know what to do. Rock, Scissors, Paper. Rent, Buy, ARM.
Japanese style stagnation means USA faces another 15 years of no job growth, no inflation, and continuing low interest rates. Prices of OC housing remains same as today and does not move upwards and does not collapse. In this case ARM loan saves a buyer significant money.
Hyper inflation leads to housing costs gaining quickly as prices of all goods appreciate. Incomes are forced to increase to keep up and interest rates rise significantly. In this case a fixed low interest rate loan becomes golden as simple bank savings pay interest greater than loan rate.
Pop goes the bubble. Current housing pricing appears reasonable due to FED artificially depressing interest rates. Remove the FED, interest rates raise to normal 7%-8% and current housing prices become unaffordable vs. rents. Current owners on fixed rate loans are trapped in affordable loan payments, but can not sell property. ARM loan holders are fucked and will be forced to default. Renters will have an opportunity to purchase at lower costs, but continue to face very low inventory levels.
Am I reading this wrong?
So, who can tell me the future?

Hey Bob … one of the issues here is you bring inventory remaining low in the future:

“Renters will have an opportunity to purchase at lower costs, but continue to face very low inventory levels.”

This is certainly a challenge in a Pro 13 bubble market where empty nesters chose to not downsize their home due to incredibly inflating prices and tax benefits. If you drive through communities in North Orange County, you’ll see less children and more retired people. There are housing tracts in Placentia, Fullerton & Huntington Beach, etc, etc, where the majority of the people are retired, or close to retirement.

I believe this is creating pent-up future supply. As they die, these homes will come to market.

It will be a source of future supply, but nothing about it will be pent-up. You’re talking about a 30-40 year generational wealth transfer. Some of the properties will be sold as the parents age or die, but many will be kept by the kids that inherit the property, either to rent out or occupy themselves.

The Millenial generation is larger than the Boomer generation, and for many this will be their one chance in life to own prime OC real estate.

Although I haven’t seen his gold, I believe he has it. He sold his house in Long Beach in 2005 and bought gold. He sold some of his gold to buy a house in Coto de Caza in 2011. His timing on those transactions was tremendous. If he had sold all his gold in 2011, he would be a legend.

I don’t know why he has been so obnoxious toward you in his comments. Even he recognizes he’s been over the top.

My comments make him uncomfortable. I am a challenge to his theory of inflation. I’m continuously pointing that the “gold to $5,000 & The Fed will never taper” people, are wrong. There is no inflation, and there are tremendous deflationary forces ahead.

“I do not believe that you bought all your “gold” (if you have any at all), prior to the bubble forming.”

Yeah? So? It is your typical behavior. Why should you? It does not fit your preconception, therefore it can not be true.

“My comments make him uncomfortable.” Ok, and why am I uncomfortable with your comments?

“I am a challenge to his theory of inflation.”

My theory of inflation? What is that? That the Fed has added $4 trillion to the money supply? That the price of some assets and consumer items has increased? What exactly is my theory of inflation?

“I’m continuously pointing that the “gold to $5,000 & The Fed will never taper” people, are wrong.”

When did I say that the pog was going to $5,000? You and I are in complete agreement that I was wrong that the Fed would never taper. If we are in agreement, how do you draw the conclusion that I am either uncomfortable with or don’t like you saying it?

How exactly does your saying, “There is no inflation”, make me unmcomfortable? Your ignorance does not make me uncomfortable. It just makes me realize that you take a stand and stick with it no matter how wrong you are. I am not incomfortable with that. Quite the opposite. It makes you sound silly, and I kind of enjoy it.

“there are tremendous deflationary forces ahead.”

No argument from me there. I do recognize what the Fed’s response to deflationary forces are.

The federal reserve has been adding money to the money supply, but write offs on non-performing loans where the banks can’t recover their capital through foreclosure destroys money. The rate of printing money has been offset by debt destruction; thus we have deflation rather than inflation.

“The rate of printing money has been offset by debt destruction; thus we have deflation rather than inflation.”

I don’t think so. There has been a bit of debt destruction, but not enough to offset the increase in the money supply, and not even close to enough. The increase in the money is manifesting somewhat in higher consumer prices, more so in home prices, commodities and precious metals, and in stock prices, but mostly in bond prices.

“There has been a bit of debt destruction, but not enough to offset the increase in the money supply, and not even close to enough”

A large amount of the money the federal reserve printed isn’t circulating because it’s sitting in the vaults of the major banks improving their capital ratios. The federal reserve will remove this excess once the velocity of money starts to increase and aggregate debt levels rise.

Total mortgage debt is down (1 trillion?), but most other types along with the money base are up even more, not to mention public outstanding debt. I have yet to see anyone estimating the total money supply today at something other than an all time high.

I believe we have stagflation. Which is horrendous for the middle class. So we have inflation and deflation at the same time, wages and consumer goods are in deflation while certain items (like food and fuel) and asset classes are increasing in value. Eventually one force will be stronger either inflation or deflation. My money is on continuation of stagflation leaning toward deflation.

Why would you feel like he MEANS something other than what he says? IR said yesterday that he thinks Lee MEANS treasury yields are low, instead of what he said, “treasuries are cheap”.

I acquiesce that consumer price increases sometimes manifest with corresponding wage increases, but often they don’t, and I have mentioned that. Lee’s response is that without wage increases there is NO INFLATION. PERIOD! I am not exagerating. That is what he said, and continues to say.

Why does everyone want to make excuses for him when he is wrong? What is so awful about being wrong? What is awful about saying, “You’re wrong”, and then explaing why?

I agree that he is using the term inflation incorrectly.

If you give me five reasons why the price of gold will go down and I show all five reasons to be wrong and based on poor logic or incorrect assumptions, and I say I think the price of gold will go up, does it mean that the reason I am pointing out your poor reasoning is because I don’t like your preposition that the pog will decrease or because I just happen to know about the subject at hand. People seem to think that if you have an opposing viewpoint, that any descrepancies you point out in their reasoning is not valid. If you tell me that ‘Cash for Gold’ stores are a contrarian indicator that gold is in a bubble, my bias toward the pog is irrelevant to the rightness or the wrongness of the ‘Cash for Gold’ statement.

“If you point out how wrong I am, it means that you don’t like what I have to say.”

One of the biggest indicators of a lack of affordability is a high percentage of properties for sale above the conforming limit. These markets are supposed to remain inflated because move-up buyers bring equity and push up prices. Over the last 10 years, most of this equity was squandered in a housing bust and HELOC boom. As it stands, these properties are overpriced and unlikely to sell.

“One of the biggest indicators of a lack of affordability is a high percentage of properties for sale above the conforming limit.”

The intent of the conforming limits was to limit the scope of government subsidy. By definition, any loans above this amount are to non-lower-income households. The limit is not intended to say anything about affordability.

If the government set the conforming limit at half the current limit, would every home in California be overpriced? If the government set the limit at twice its current limit would most California homes be affordable?

The conforming limit in California was 1.25% the median home price or 729,750, whichever was lower. The limit was reduced to 1.15% the median home price or 625,500, whichever is lower. The high point was right after the financial crisis hit and credit availability was a concern. The limit was lowered to encourage private lending to resume above the limit. Mission accomplished. More private lending is occurring now that the government isn’t giving away cheap loans. To me this indicates that buyers see homes as being affordable above the limit despite the absence of low government subsidized rates.

With jumbo loan rates equal to or less than conforming loans, loan limits don’t factor into most buyer’s calculations. If you have 20% down, then there is no reason to consider conforming loan limits. If you don’t have 20%, then reconsider buying with a government loan. FHA fees make renting look much better by comparison.

Effective jumbo rates are much lower than conventional thanks to the MID. Most conventional buyers aren’t taking full advantage of the MID if they are at all. On a $1M loan you would pay $45k interest plus about $14k in taxes. So, your tax deduction is going to be about 0.28*(59k) = 16.5k/yr. Subtracting this from your interest >> 45 – 16.5 = 28.5k, or 28.5/1000 = .0285% effective rate.

The effective rate will rise for a fixed mortgage as the principal is paid down and the MID is reduced with lower interest payments. The MID is one of the leveling factors between FRM and ARMs that never gets discussed. As ARM rates rise, the amount of interest paid every year also rises, which also increases the MID. More interest is paid during the mid-span of the 30yr loan, when households are entering their peak earning years and desperately need a tax deduction. As long as the ARM cap and adjustments are reasonable, then ARMs can make sense.

I know someone that just bought a million dollar home in Irvine with a 7/1 ARM in the low 3s that has a 6.5% cap and 1.125% adjustment. I think he’ll do just fine. He will save about 50k the first seven years, and start to pay current market rates about 8-9 years from now with the first adjustment. With the MID, the effective cap is (1-0.28)*3.25 = 2.34, or 3.25+2.34 = 5.59%. With amortization and applying difference between FRM and ARM payments, he will have paid off 26% of the principal by the time the maximum rate hits.

The details do matter, a lot. If you run through the worst case ARM scenario, taking into account current tax code, and reasonable estimates for future earnings, the differences between fixed rate and ARM aren’t as great as they may seem. Normalizing payments between FRM and ARM over the life of the loan, the net interest after MID is about 70k higher for the ARM at payoff. The net interest curves intersect at payment 166. After that point the FRM is paying a lot more principal than the ARM and pays off in 300 payments. The ARM pays off in 335 payments.

Payment shock isn’t an issue since I assumed that you can afford the fully amortized FRM, and ARM at max cap rate. If you can’t, then you shouldn’t buy the house. If you can afford the adjustment, then and ARM can save you quite a bit of money for the first 10-14 years of the loan. If you plan to stay longer, then a FRM makes more sense.

If rates go up dramatically, both FRMs and ARMs will equally impact the resale price. So there is no advantage to a FRM in that case.

Despite a weak first quarter, home prices are still expected to rise by 7% in 2014, according to Wall Street analysts.

“We continue to expect home price appreciation to moderate from the torrid pace of mid-2012-13, supported by improving employment and growth prospects,” said analysts from Morgan Stanley (MS). “We leave our 2014 projections for new home sales (450-500 thousand units) and home prices (up 5-7% for the year) unchanged.”

Analysts from Barclays (BCS) agree. “Our base case projection for 2014 US home price appreciation is unchanged at 7%,” said analysts from Barclays.

Below are five other housing insights from Morgan Stanley and Barclays analysts:

1. Barclays’ analysts highlight the projected home price appreciation for the four “sand states”: Arizona, California, Florida and Nevada

Barclays’ raised its home price appreciation projections for Arizona and Florida from its previously reported projections. Barclays’ projection for Arizona was raised from 6.8% to 8.2% and Florida was raised from 7.7% to 8.3%. Barclays’ expectation for California remains static at 9.4%.

On the other hand, Barclays’ home price appreciation prediction for Nevada was dropped from 12.9% to 11%.

2. Morgan Stanley analysts downgrade their projections for existing home sales in 2014

Morgan Stanley’s analysts are now projecting existing home sales to between 4.75 and 5 million units, down from their previous projection of 5.25-5.75 million units.

3. What explains the weakness in housing right now?

“In our view, the rationale for the weakness comes from a combination of three factors – severe winter weather; a transition away from investors reliant on distressed and cash purchases to mortgage credit- dependent buyers; and affordability challenges for first-time homebuyers,” Morgan Stanley’s analysts said.

The analysts also cite the nearly 20% of homeowners that remain underwater as of the fourth quarter of 2013. The analysts say that the concept of moving is especially challenging for these homeowners.

“Not only would the homeowners have to put up cash to make up the difference between the outstanding mortgage balance and the sale price of the house, but they would also need to find the money for the down payment on their new property,” the analysts said.

4. What’s the story out West?

Morgan Stanley’s analysts note that home sales are down in the western part of the country. That area is not as susceptible to a winter slowdown due to its milder climate. The analysts suggest that the slow down in the West is due to decline of distressed transactions and “the constraints faced by the traditional mortgage-dependent buyers.”

I hate to say it but $8B isn’t what it used to be. A better title would be: “Balance of Severely Delinquent HELOCs is ONLY $8B.” The major banks could write that down in one quarter. I thought it was a lot worse than that.

Following months of stagnancy, the National Association of Realtors’ (NAR) measure of pending home sales rose in March, the group reported.

According to the latest release, NAR’s Pending Home Sales Index (PHSI) rose to 97.4 last month, up 3.4 percent from February’s upwardly revised 94.2. It was the first real pickup in the last nine months, the association said.

NAR’s chief economist, Lawrence Yun, said the increase was expected with the end of last season’s severe weather.

“After a dismal winter, more buyers got an opportunity to look at homes last month and are beginning to make contract offers,” Yun said. “Sales activity is expected to steadily pick up as more inventory reaches the market, and from ongoing job creation in the economy.”

Yun’s optimism matches forecasts from other industry analysts, who continue to project a rebound in spring and summer despite a poor early showing for home sales.

Compared to last year’s more active season, pending home sales remain down 7.9 percent; it remains to be seen whether the latest report—which is based on contract signings, not closings—will translate to a substantial increase in final sales figures over the remainder of spring. For the entire year, NAR forecasts existing-home sales numbers of 4.9 million, below the nearly 5.1 million recorded last year.

At the regional level, pending sales were up in the Northeast, the South, and the West, rising 1.4 percent, 5.6 percent, and 5.7 percent, respectively. The Midwest’s PHSI slipped 0.8 percent, meanwhile.

A new survey conducted by Harris Poll and national brokerage Redfin suggests one in four Americans regret purchasing the home they currently live in.

Out of a poll of more than 2,000 homeowners, Redfin found an even 25 percent would not buy their current home if they had a chance to do it over. Most of the dissatisfaction came from younger people and stemmed from their relationship with the real estate agent, suggesting a generational divide.

Not surprisingly, the group with the least buyer’s remorse were those over 65. In that group, 85 percent said they would buy their home all over again, whereas 72 percent of those 18 to 64 felt the same.

Regionally, the Midwest was the highest in this category at 28 percent, with the Northeast at 27 percent, the South at 25 percent, and the West at 20 percent.

As for gender and family, 27 percent of women experienced buyer’s remorse, while 28 percent of people with children under the age of 18 in their home felt this way.

From a socioeconomic standpoint, those with a higher education and income were happier with their homes, with 86 percent of those that made over $100,000 expressing satisfaction, as opposed to the 70 percent under the benchmark. Those with college degrees showed an 82 percent satisfaction, as opposed to 72 percent otherwise.

With more than 89 percent of respondents using a real estate agent in the last ten years, 47 percent “loved” their agent, but those in the 18 to 34 category only accounted for 31 percent as opposed to the 52 percent among ages 35 to 44.

“We commissioned this survey because Redfin agents have seen firsthand the pressure homebuyers face in 2014,” said Redfin CEO Glenn Kelman. “With flash sales, bidding wars, price jumps and inventory crunches in many markets, it’s important to have a real estate agent who is just as motivated to have you walk away from a bad house as to pounce on a good one.”

The Senate Banking, Housing and Urban Affairs committee is kicking the housing reform can down the road a week or so, delaying a markup of the Johnson-Crapo housing reform measure to enable supporters to get a few more votes after a two-week recess.

Johnson-Crapo is one of four GSE reform measures on the Hill. The other primary contenders are the House’s PATH Act, the House’s HOME Forward Act, and the Senate’s Corker-Warner. (The full report on the measures from the Structured Finance Industry Group can be read or downloaded here.)

“I am confident that if we held the vote this morning, we would have more than the minimum number of votes needed to pass it on to the Floor,” said Sen. Mike Crapo, R-Idaho, the ranking minority member and co-author of the bill. “Nevertheless, while I do not relish the idea of a short delay, I am pleased that a number of Senators believe with just a brief period of additional time to consider it, they will have the opportunity to productively join us in efforts to reform the current system.

“I look forward to working with my colleagues in the coming days, to listening to their questions or concerns to help us find a bipartisan consensus with even stronger votes,” Crapo said.

The four reform measures could have substantial impact on housing and mortgage rates.

David Steves, president and CEO, said Johnson-Crapo has the votes to make it from committee already, 12-10, but that sponsors wanted other senators returning from a two-week recess to have more time to get on board.

“We expect the vote by the end of next week,” Stevens said.

Should the Republicans take the Senate, as it appears they could at this time, it’s very likely Johnson-Crapo could be scrapped or modified in favor of something that looks more like the House PATH Act. But a more conservative measure in turn would face a roadblock at the White House.

Johnson-Crapo would unwind the role of Fannie and Freddie, replacing it with a model where financial entities would issue mortgage-back securities and be required to take losses before any government insurance relief is available.

“Housing finance reform remains the most significant piece of unfinished business from the 2008 financial crisis. Fannie Mae and Freddie Mac greatly contributed to the housing bubble, the financial crisis, and the dramatic government intervention that resulted,” Crapo said. “The current system is unsustainable, leaves taxpayers exposed to potentially trillions of dollars in liabilities, and has left the mortgage market in a state of limbo, forcing private capital out of the market.”

When it comes to real estate, we know that Californians enjoy drinking from the gold cup of mania. Lusting over real estate seems to be as common as traffic on the 405. People in California have a deep rooted cultural and economic amnesia. I bet half the population has very little idea regarding the history of many cities in Southern California. Heck, most don’t even know where their drinking water comes from. So trying to discuss Fed policy, skewing based on investors, or market manipulation with a large portion of people is like talking to your dog about Hemmingway. Some people only understand “real estate goes up!” and when it doesn’t, they only understand “buying is bad!” California real estate is overvalued by most economic measures. Sure, people are willing to pay insane prices but they did this as well in 2006 and 2007 and people also paid crazy prices for tech companies in a previous delusion based boom. Investors are pulling back because they simply don’t perceive value at current prices. We are now seeing more reports putting a price on how overvalued the region is. Fitch Ratings and Trulia both point to SoCal as being massively overpriced. In fact, Fitch Ratings has Orange County overvalued by a whopping 30 percent. Congratulations to Orange County for being the most overpriced county in the entire United States.

Real Overpriced Homes of California

Orange County is back in full bubble mode. This year however, we have seen inventory increase even in prime areas like Irvine. Paying $500,000 for a poorly built condo with mega-HOAs isn’t exactly a deal. I know some people that have paid off condos that pay $1,000 and more a month just in HOAs, taxes, insurance, and maintenance. You want cable, food, and internet? Add that in as well. Keep in mind these are people that failed to fund retirement accounts or build any other income streams because they thought “hey, once the home is paid off I won’t have any other costs!” Wrong. It is crazy to see people living in $500,000 to $1 million homes shopping at Wal-Mart and the 99 Cents Store because their budgets are so stretched. I’ve seen a handful of pizza delivery people driving in fairly new Mercedes and BMWs. Living the California dream baby! This is the type of financial logic that permeates in the region.